Investing in real estate is a rewarding and lucrative venture. However, as with any other type of investment, inherent risks are involved when buying a property. While you cannot eliminate risks altogether, you can minimize the chances of them happening and mitigate the damage they may do.
In this article, you’ll find out the prevailing threats in the real estate industry and how to mitigate property investment risks regardless of whether you’re a buyer, seller, or investor.
8 Risks of Real Estate Investment and How to Mitigate Them
1. General Market Risks
A general market risk you should be aware of is the real estate industry’s unpredictability. Contrary to popular assumptions, a real estate investment does not always move in an upward direction. The sector is cyclical in nature, meaning market changes could happen at a certain point.
For instance, in the central business district of Makati, real estate prices grew by 125% in eight years, from 2010 to 2018. But in 2020, property values in the same area suddenly plunged by 13.2%.
Indeed, real estate is vulnerable to fluctuations in supply, demand, demographics, interest rates, government policies, and natural disasters. Some investments that may have a high demand at one period could suddenly hit below-market value with transitions in the housing market.
How to Mitigate: You must conduct a market analysis, a study on the economy, and inspection of a property, as well as schedule consultations for financial projections to predict the success of a real estate investment and the best time to put it in the market.
Additionally, you should diversify your property portfolio by investing in different types of properties (apartments, condos, townhouses, and commercial buildings) to give you some wiggle room in case the market for one type of property suddenly drops.
2. Location Risks
Location significantly determines the value of your property. While being in a good neighborhood and being in a good street location is great for any property, you should also take into account the other intangibles that come with the location. Crime rates, unemployment rates, and a declining population could greatly increase the risks you may incur with your property investment.
How to Mitigate: To assess a property’s location, you can read up on current news about developments in the area. Analyzing the trends and statistics about income growth, crime rate, vacancy rates of competing properties, and the population growth in the area can also help you weigh the risks.
Similarly, seeing the area for yourself can also help you test the waters and discover things not usually covered by statistics, research, and projections. So, apart from the numbers, economic analysis, and an interior or exterior examination of the structure, you must perform a neighborhood inspection and ask residents questions that you may have in mind.
Finally, purchase properties in different locations to diversify your investment opportunities. If the market value of properties in one place drops, you can still earn from other sites. Specifically, purchasing a property in opposite geographies can let you take advantage of the fluctuations in the market.
3. Liquidity Issues
Investing in rental property is a great source of passive income. While its ROI is promising, the liquidity risk of properties is also high, given that they are long-term assets. Along these lines, selling a property means liquidating your investment quickly, but the wrong timing can hamper its profitability.
While real estate investments are typically stable, their long investment horizon could expose you to risks over time such as recessions, property damage, and high vacancy rates. Awareness can help you form realistic expectations about your desired ROI and determine if the potential real estate investment risk and loss from a property are worth your time.
How to Mitigate: Mitigating liquidity threats comes down to having a reserve fund to meet immediate obligations and creating a good mix of short and long-term investments.
So, instead of just buying rental properties, you could add commercial leasing, property flipping, and listing on online lodging marketplaces like Airbnb to diversify your streams of income.
4. Leverage Risks
Leverage is when you use bank loans, mortgages, informal debts, or borrowed capital to fund your property. Leveraging allows you to extend your purchasing power even with limited capital. However, this could be riskier in that if you do not control your cash flow or are unable to pay the loan back, you may lose your investment.
How to Mitigate: The more your investment is financed by debt, the greater the chances of losing your property quickly. Nevertheless, the risks from leveraging can be prevented by budgeting for potential vacancies, debt payments, and economic challenges.
Additionally, you can pay a higher down payment to reduce amortization and interest. A higher down payment preserves your property’s equity even with declines in market prices and can significantly influence your ability to sell or refinance your home in the future.
You may also consider debt refinancing, which is the process of raising money by selling debt instruments to a company or a financer, with the promise of giving them a portion of your future earnings. However, it is crucial to leverage your investment portfolio at a maximum of 70%.
5. Asset risks
A real estate investment is a physical and tangible asset that can’t just disappear into thin air, unlike stocks or cryptocurrency. However, a sudden downturn in a specific market, say the office space market, can spell doom for an investor whose focus is mostly on commercial property.
Apart from asset type, you should also carefully consider the asset class. Do you have a good mix of entry, mid, and high-end properties? If not, you may not be diversified enough and may be more exposed to asset risks.
How to Mitigate: Weathering these potential economic storms and investing in long-term growth can be achieved with asset-type diversification. You can invest in multi-family homes, single-detached structures, apartment complexes, industrial storage, and commercial spaces to leverage the benefits of each type of property.
For instance, a large luxurious apartment might be more in demand among those who value both comfort and aesthetics. On the other hand, some people might downsize and look for cheaper rentals during recessions.
You can also mitigate asset risks by diversifying your strategy and holding time. Some properties are perfect to flip, while others can significantly appreciate in the future with a buy-and-hold approach.
6. High Vacancy Rates
Short-term or occasional vacancies can eventually run long-term, making it impossible for you to stay on track of your mortgage payments. Extended vacancies can occur if you can’t find a suitable tenant or if the demand for your property is slumping.
In Metro Manila, the residential vacancy rate grew by 7.3% in the first quarter of 2021, from 7% in 2020 and 3.5% in 2019. Attributing to this decline in vacancies is the pandemic.
Nevertheless, you can prevent vacancies before purchasing a property by researching the usual vacancy rate in the area and observing how often or how extensive those rates change. This way, you have a better understanding of your asset’s risks once you decide to enter the market.
How to Mitigate: A more involved property management style can make it harder for your tenants to leave their rental. Try your best to make them feel at home and get to know your customers. You can also consistently ask for feedback on improving the place. Apart from profits, you might even find managing rental properties more enjoyable.
Quickly sprucing up a unit for the next renter can also shorten your rental turnover. Keeping your rental units clean by setting house rules can make a good impression among prospective tenants that they have found an ideal property.
Similarly, timely repairs and regular maintenance projects can help ensure that your property is in top condition. Repainting the exterior and making it look homey as possible can attract clients.
Additionally, researching the rental rates in your location, knowing the slow seasons for rentals, determining which part of the real estate cycle you’re in (expansion, contraction, recession, and recovery), and pricing your property competitively can lengthen the rental terms of your current tenants and help you strategize and navigate the market like a pro.
7. Problematic Tenants
Every landlord’s nightmare is having an inconsiderate tenant who does not pay for their rent on time, damages the unit, or disturbs other renters. Sometimes, calls or messages are not enough to address the situation. To deal with problematic tenants, it’s better to take early measures.
How to Mitigate: To ensure your tenants don’t get problematic, conduct frequent visits to your property. Semi-annual visits are ideal for keeping your area maintained. If you observe that the tenant is not taking care of the place, it’s better to address it sooner than later. Also, if a tenant decides to move out, compare the initial condition of the premises to the current one. If you find any damage, they must be held liable.
When renting your property, discuss lease agreements and clarify each tenant’s responsibilities regarding the terms and boundaries you want to enforce. Once the lease contract is signed and payment options are structured, check their payments every month to make sure they observe their due dates.
Pre-screening tenant applicants and viewing their criminal history or qualifications can help you steer clear of dangerous renters. Checking their employment status, bank records, or payslips can also help you determine their financial health or ability to consistently pay rent or mortgage.
8. Property Damage
Damage to property premises can arise from careless tenants, the lack of maintenance on your part, unexpected hazards (such as fire, robbery, or vandalism), and natural disasters.
Lack of maintenance – think tree branches hanging dangerously, an unstable foundation, faulty wirings, inefficient plumbing, or cracked walls – can cause accidents. This can make you liable for the possible hospital bills of your residents.
If the cause of damage is natural disasters or unexpected events, you may not be able to prevent them, but you can take tangible steps to minimize the costs from these events.
How to mitigate: Property insurance can limit the risk from disasters and cut down losses. The most crucial factor you must consider when determining the coverage of your home is its location.
Avoid real estate investment that is situated in a flood-prone area, close to frequent forest fires, or threatened by landslides. Insurance can help you cover losses in case these unfortunate events take place.
Apart from property insurance, you might also want to consider getting general liability insurance. This covers the medical expenses of your residents in case they get injured on your property. If your tenants sue you, general liability insurance can help in funding your legal expenses. It can also cover repair costs for your property.
Consider installing a surveillance system for security purposes, too. This is to discourage crimes and illegal activities (violence, fraud, drugs) from taking place on your premises. With surveillance cameras, you can document incidents of someone damaging your property and determine if there’s unusual foot traffic in your property.
Your real estate investment is not free from risks. Its cyclical nature makes it crucial for you to diversify your real estate portfolio in terms of location, asset type, and investment strategy.
Minimizing risks and maximizing returns can also be achieved with ample research, consulting with a reliable real estate broker in the Philippines, and being aware of industry trends. If you do it right, your real estate investment can appreciate long-term and bring you plenty of returns.
Are you ready to reap the multiple advantages of real estate investment? What about diversifying your portfolio with your next property?
Find properties for sale by contacting the real estate experts at RE/MAX for a free consultation. REMAX Gold has the best-in-class service in guiding you towards your real estate property investing journey.